VentureBlog

What's Left To Say About Participating Preferred Stock?

Man has Venture Blogging come a long way since we started VentureBlog a year and a half ago. At that time, the only way that there would be robust discussion and debate about venture capital related topics in the blogsphere would be if Andrew and I took different sides of an issue and duked it out on VentureBlog. Now folks like Brad Feld from Mobius Venture Capital and Fred Wilson from Flatiron Partners are discussing and debating VC issues of real interest and import. While Venture Capital still remains quite individualistic and, at times, enigmatic, VC bloggers have gone a long way to help demystify what has for years been a bit of a black art.

It struck me just how much information was being shared these days as I read a set of posts about Participating Preferred Stock by Brad and Fred. While there are real world implications to decisions made by VC's and entrepreneurs about Participating Preferred Stock, this is still a pretty esoteric topic. As recently as a year ago, the posts about venture financings were pretty rudimentary (here's what Joi was talking about, and here was my effort to just put the terms in context). Brad and Kevin Laws (at VentureBlog) upped the anti with deeper analysis of Preferred Stock. And now there is a debate raging online about the use and appropriateness of Participation in Preferred Stock. The real debate, mind you, is in the comments of Brad's and Kevin's pieces (we VC's are far too gentle on one another but entrepreneurs are more than willing to call BS when they see it).

Quantitative Evidence Of An Upswing

I am often asked if things are feeling better in Silicon Valley. Are things looking up? My answer is essentially "yes." Things do feel better. Serial entrepreneurs who sat out the early 2000's are getting back into the game. Deal flow has picked up across the board. The public market for technology stocks is opening up . . . a bit. Later stage venture investors are more enthusiastically looking for opportunities to put money to work. The environment really is feeling better. But as much as it's feeling better, it has just been that, a feeling. Until now.

I've written about Fenwick and West's survey of venture financings before. Fenwick has been tracking venture financing terms since the second quarter of 2002. In this quarter's survey (First Quarter 2004) Fenwick is reporting a noticeable and uniform upturn in venture financings. For the first time since 2002, the number of up rounds (51%) exceeded flat (19%) and down rounds (30%) combined. In fact, the percentage of down rounds decreased in every series, most notably in Series E and higher. Terms generally followed price as well, with less punitive liquidation preference and anti-dilution being the norm. Given all that, I would say that we have our first quantitative piece of evidence that the venture financing environment is on the upswing. That's good news. I hope that the trend continues.

Ok, that said, despite the apparent evidence of an upswing, lawyers can never leave well enough alone, can they. The Fenwick survey points out, "it is important to bear in mind that most of the companies that raised funding this past quarter last raised funds 12-24 months ago, when valuations were depressed." Sure, that's true, but the environment still feels better to me. So we'll have to wait and see if the trend continues.

Venture Lending 101

Many of the companies in which I invest spend more money than they make for considerable periods of time. Given the early stage at which I invest, this is neither surprising nor necessarily concerning (even those companies that could be cash flow positive if they so chose, often go negative in an effort to accelerate their growth). Nonetheless, it is an important factor with which I must deal as I try to help my portfolio companies move forward. After all, at some point any company burning more cash than it makes will have to acquire more money or go out of business.

Steve Case Makes A Career Of Vacationing

What do you do with your time when you're a retired Internet mogul? Some would say the thing to do is go on vacation. Instead, Steve Case has decided to buy vacation. As is announced tomorrow morning in the Wall Street Journal, Steve Case has recently purchased a 50% interest in a elite vacation club called Exclusive Resorts. Exclusive Resorts is in essence a high end timesharing company -- but unlike the 1 bedroom condo in Tanglewood my family enjoyed a week each summer when I was growing up, Exclusive Resorts has over 30 multi-million dollar homes (in places like Wailea, Los Cabos, Telluride and Whistler) that club members can use at any time (at least so long as someone else hasn't reserved the house). Exclusive Resorts was started by Brad Handler, Ebay's first attorney and another Internet Retiree. Handler started Exclusive Resorts after he found a lack of great vacation experiences available for his family, including his two small children. Like Case, Handler determined that there was no better way to enjoy retirement than to make a new career of vacationing.

What strikes me as significant about Steve Case's investment in Exclusive Resorts is that he is not only investing his money but also a significant amount of his time. Case has gone on the Exclusive Resorts board but, more significantly, he is scouting properties, soliciting board members and advisors, recruiting executives and generally lending his good name and power of persuasion to the enterprise. There is no question that Exclusive Resorts will get great value out of Case's involvement. It is precisely the sort of value that entrepreneurs should look for from their investors, be they angels or Venture Capitalists alike.

High Tech Energy Crisis

According to the San Jose Mercury News, a recent survey by Deloitte & Touche demonstrates that increased scrutiny of option issuance has resulted in a notable decrease in option use by tech companies. 73% of the public companies surveyed said that they have reduced or will reduce the number of options they issue in the coming 12 months. And two thirds anticipate overhauling their compensation plans if the accounting rules require the expensing of options. To my mind, those are devastating numbers. Stock options are the fuel upon which tech companies are propelled. They give everyone in a company the incentive to strive to make the most of that company. If those incentives are dismantled, I fear that startups will no longer achieve the same velocity that has historically been the case in the United States. And that is not an economic advantage this country can afford to lose.

Business As Reality Programming

As I've mentioned before in VentureBlog, I'm a big fan of the marketing genius of Mark Burnett (of "Survivor" fame). Well according to the New York Times Mark Burnett's business hero is Donald Trump. While he was selling t-shirts on Venice Beach and nannying in Beverly Hills (before he became the crazy millionaire, stranding folks on deserted islands), he was reading Trump's "The Art of The Deal" and gaining inspiration. Now Burnett and Trump have teamed up to create a reality show about business. Each week contestants will do pseudo business tasks that Trump walks them through. He claims he's hosting the show for educational purposes. According to Trump:

I think there's a whole beautiful picture to be painted about business, American business, how beautiful it is but also how vicious and tough it is. The beauty is the success, the end result. You meet some wonderful people, but you also meet some treacherous, disgusting people that are worse than any snake in the jungle.

It's not too profound, but that's entertainment isn't it.

Audience As Economic Indicator

I sat on a couple of panels this week. Neither one had quite the hype of Andrew's bubblet panel. But both were surprisingly well attended for mid-week panels on the venture process. The panels were fairly generic -- one was on the current state of venture finance terms and the other was on the importance of management teams in growing startups -- yet both drew crowds that included a couple dozen startup CEOs in waiting. I've done a number of these panels over the last few years and to the extent that these things are indicative of economic trends, I would say that the startup world continues to look up.

Rock Concerts Are A Marketing Device

According to an article in the New York Times this past weekend, later this year Ticketmaster will begin auctioning off the best available seats for concerts that it is ticketing. According to John Pleasants, Ticketmaster's president and CEO, the fact that there is a thriving secondary ticket market suggests that concert tickets are unpriced today. Rather than put those additional dollars in the pockets of ticket brokers, Ticketmaster contends that those dollars should go to the promoters, venues and musicians themselves. Thus, Ticketmaster is going to offer its clients the ability to auction off tickets to their events. Pleasants calls primary market ticket auctioning the first step in "a new age of the ticket."

It is clear that Pleasants has a point about ticket pricing -- tickets to many concerts are unquestionably underpriced. Ticket brokers have long been the beneficiaries of that underpricing. More recently, eBay and other auction sites (like StubHub) have enabled a broader range of people to benefit from the arbitrage between a ticket's face value and its fair market value. With Ticketmaster's new pricing scheme, Ticketmaster's clients will be able to capture all of that value and in so doing derive greater return on the same limited number of seats, which venue operators will no doubt applaud. The same may not prove true of performers.

Ticketmaster's new pricing scheme ignores one important factor -- to my mind, rock concerts are as much about marketing as sales. Bands tour to promote themselves and promote record sales. While bands can certainly make a pretty penny touring, traditionally tickets have been priced so that they are accessible to their entire fan base, not just the richest groupies. Moreover, the poor fan with lots of time on her hand was supposed to have as good a shot at getting the best seats as was the rich guy with a big checkbook. I suspect that a band's loyal fans will not take kindly to rich folk buying up the front rows and leaving them to fight for the back of the house.

Perhaps the idea of the rock concert as marketing vehicle is an outdated concept and fans are willing to accept that tickets will sell for whatever the market will bear (if my recollection serves me correctly, Barbara Streisand was the first one who was willing to truly test the outer limits of market pricing and discovered that the prices for her shows were far more inelastic than anyone would have previously guessed). But you'd think that Ticketmaster would have learned from its feud with Pearl Jam almost a decade ago. There is something about rock concert tickets that elicits a visceral reaction from the ticket buying public. And if that reaction is an overwhelmingly negative one, variable pricing could easily backfire on the bands that first choose to implement it. If I were John Pleasants, I would roll out ticket auctioning very slowly and very carefully.

UPDATE: My brother emailed me after I posted this entry and told me that I was completely wrong. He argued that every time Red Sox ticket prices have been jacked up, fans have grumbled like crazy but always ultimately come back and paid the toll. Despite his firm belief that I am wrong and that there will be no backlash from concert ticket auctioning, he just sent me this article in which a number of sports venue managers state that they will not allow auctioning of their tickets. As the article concludes:

[T]he primary risk, according to Baker [of StubHub], Thomas [of Tickets.com] and team executives, is at the public relations level. Teams and venue operators are fearful of the perception that they are gouging fans.

No Admission For The University Of California

In his excellent article on the unintended consequences of the public disclosure of Venture Capital data, Tim Oren writes:

The next unintended consequence is that public entities will have more trouble placing their money into venture capital funds. Venture capital management firms prize investors who are loyal when times are bad. They dislike investors who create extra burdens of reporting and entanglements with regulation and politics. Compared to private institutional investors, public entities will become a denigrated class.

Looks like Tim was right. In an article (registration required) earlier in the week, the Los Angeles Times reported that Sequoia Capital will no longer allow the University of California to invest in its funds. In the words of UC spokesman Trey Davis, Sequoia "kicked us out over concern about public disclosure." Can't you just hear Tim saying "I told you so."

Q2 Venture Economy Looking Up

Mike Patrick and Barry Kramer at the Bay Area law firm of Fenwick & West have been collecting venture finance data since the beginning of 2002. They report their detailed findings quarterly. Here's the link if you're interested in having their quarterly survey emailed to you directly. Based upon the 94 venture financings they tracked in the second quarter of 2003, Mike and Barry conclude:

The terms of venture financings improved somewhat in the second quarter of 2003.� The percentage of financings that were down rounds decreased (although we note that a majority of financings were still down), the percentage of Series A financings increased, and the other terms of financings were generally less tough than in Q1 '03.�

Consistent with this trend, we note that various industry publications have also reported an improvement in the venture financing environment, showing an average 7% increase in the number of financings from Q1 to Q2 '03 and an average 10% increase in the amounts invested over the same period.

There are a couple statistics that I find particularly encouraging as an early stage venture investor. First of all, a greater number of early stage companies are getting funded than in recent quarters. Last quarter a full fifth of the financings were Series A rounds and another 24% were Series B financings. That's the largest percentage of Series A deals in as long as Mike and Barry have been tracking the statistics. Equally encouraging for VCs and entrepreneurs alike is the fact that the number of up rounds (financings that got done at a higher price than the last round) increased dramatically from the previous three quarters. In Q2 2003, 40% of those rounds that got done were at an increased price (the percentage ranged from 20% to 26% for the previous three quarters). Moreover, only 26% of the Series B financings that got done last quarter were down rounds.

That's great news and a pretty solid indicator that the venture economy is on the mend. Let's hope for a continuation of those trends in the second half of 2003.